Malaysia’s Coffee Scene Is Brewing

As Malaysians, we are spoiled for choice for coffee:from robusta/liberica-based kopi-Os, pak kopi (white coffee),? to more premium arabica-based americanos and lattes. We are spoilt for choice. And as a coffee addict, I’m not complaining. We have seen this sector exploding over the years with importers, roasters and cafes expanding rapidly. We’ve also attracted foreign players such as Indonesia’s Kenangan, South Korea’s Coffea and Paris Baguette, Singapore’s Bacha and now are also looking forward to Luckin’s arrival, while its main rival in China, Cotti (which interestingly were the founders of Luckin), is already here. This is in addition to the already existing offerings, incumbent chains Starbucks, Coffee Bean, Black Canyon, Dome, San Francisco, local startups Zus (which has overtaken Starbucks in number of outlets), Bask Bear (of Tealive’s fame), HWC, Gigi, etc, plus all the independent lifestyle cafes that have sprouted out. Not forgetting the cheaper offerings by convenience stores such as FamilyMart, CU, MyNews, 7-11, etc. We are adequately covered from <RM5 kopitiam coffees to >RM7 machine brewed ones, even RM50 specialty single origin hand pours. There are also the home baristas, purchasing beans from various platforms, leading to a rise in roasters and distributors both online and offline.

This excitement has recently been taken a notch higher with the IPO of Oriental Kopi and of Zus securing some major funding.

Let's revisit Old Town White Coffee. Old Town was one of the earlier kopitiams that successfully commercialized and embarked on a franchising model. After being listed for around 7 years, they were acquired and privatized by Jacobs Douwe Egberts (JDE) in 2017 for RM1.47B, which represented a 10% premium to its share price. At that time, they had around 200 outlets with RM425m of revenue and 60m of profit. This denotes a PE of 24.5, net margin of 14% and revenue per outlet of around RM2.12 mil. We’ll use them as a basis for evaluating valuations from here on.

For its IPO on the ACE market, Oriental Kopi is offering 418.1mil new shares or 21%. There is no offer for sale but the shareholders have taken a RM11mil dividend and possibly more prior to the IPO. Its prospectus provided a glimpse of their commendable achievements in just 3 years:

They managed to triple their revenue (RM133m) with doubling of their profit (RM20m) in one year, with GP and NP margins at 29% & 15% respectively. With 14 outlets, this translates to a revenue per outlet of RM8.86mil (probably more as not all cafes would have been opened during FYE2023). IPO proceeds are mainly to build a new headquarters, central kitchen and warehouse, international expansion and marketing. As of this writing, no valuation has been assigned yet, but let’s assume a PE of 25x- this would bring their valuation to around RM500mil: a major achievement when referencing their 14 outlets, compared to Old Town’s 200. Oriental’s famous egg tarts, polo buns, and hawker fare, are all part and parcel of its “truly Malaysian” branding, and the perpetual long queues are a testament to the strong market brand image supporting its respectable revenue per outlet. The founders of Oriental are also behind Black Whale and Beutea, both tea based establishments. One thing’s for sure - Malaysians sure love the retro ambience, especially for middle-aged folks like me, enabling us to take a trip down memory lane. Competitors in this space include Nanyang Coffee and Hometown Hainan

Zus Coffee’s announcement of securing a RM250mil investment has 2 parts - RM200mil to buy over old shares, and RM50mil for new shares. No other details were provided. From publicly available information. Zus has 500 outlets with revenue of RM204mil and profit of RM10.1mil (a year ago, FYE June2023). This denotes GP margin of 49.6%, and NP margin of 5%. Amidst the ongoing boycotts of western coffee establishments, Zus has been a fortunate beneficiary.

Let’s assume the RM200mil is to acquire 35% shares (35% is owned by their Filipino partners), this translates to a valuation of around RM 570 mil.

Assuming their profit doubled in FYE June 2024 to RM20mil, this translates to a PE of around 28.5x. Rumour has it that they are eyeing an IPO in the near future with a valuation of RM1-1.5B. Let’s say they double their profit again to RM40mil (conservatively) in 2025, with a 28.5x PE, valuation would then be RM1.14B, bringing it within range of the market talks. All hypothetical of course, but definitely achievable.

Oriental and Zus have completely contrasting models, but their valuations are close (with the assumptions as mentioned) and it would be interesting to see how both will pan out. At one end of Oriental is the use of coffee (and egg tarts of course) as a high-margin companion to lower-margin meals, increasing ARPU through upselling to the consumer. On the other, Zus uses coffee as the central product driven by convenience of acquiring what is almost a daily necessity by many of us - if strong enough customer loyalty can be established, the LTV can be significant..?

However, Is this just a passing fad??

Oriental invested just RM73k in 2021, RM142k (2022) and RM779k (2023) on advertisement and marketing to achieve such an impressive revenue. Clearly they have got the formula right. But will their brand equity be strong enough to withstand the test of time, trend cycles and tastes? Egg tarts, however, have a huge margin, probably around 500%. Having held the Malaysian record for most egg tarts sold in a day, will it be a strong enough pull factor?

Malaysians love all new offerings and would easily migrate to new joints. This spread of food also includes many hawker centres into the competition arena. Looking again at Old Town, it’s a shadow of its former glory.?

Zus targets a different sector, being arabica based, and with a much larger footprint but smaller outlets (focused on takeaways). They are also high tech, with their own app for pre orders and loyalty (ala Luckin Coffee). Zus’ simple modern setup attracts Gen Zs and busy professionals just wanting a no frills cuppa. Founders of Zus are all successful tech entrepreneurs, no surprise after scrolling through their slick app - somehow just entices you to order the CEO latte (I’m sure that name is not random) and completing the missions - tech infused coffee! This is definitely a strong moat as not all operators are able to scale both the online and offline space, while building a strong brand. We will definitely be seeing more aggressive blitzscaling with this new gunpowder. Competitors include Bask Bear, Cotti, and very soon Luckin. Risk in this sector is mainly the price of coffee beans, which are almost all imported, and exposed to climate change, supply/demand, and foreign exchange rates. Almost all beans are produced in South America, specifically Brazil. We’ve all seen what happened to cocoa recently. Having said that, Zus has a GP margin of almost 50% to cushion this impact.

Is there room to grow

Since the 19th century, Malaysians have begun to drink coffee, but mainly of the liberica variety, one of the least known and consumed varieties (around 1%), with the popular beans being of the Arabica and Robusta varieties. Arabica prefers higher altitudes (Sabah has started planting this). Today, Malaysia produces roughly 4,000 tons per year (around 0.04% of global), As such, almost all our produce is used locally, specifically in our kopi-Os and pre-mixed coffees. We however, need to import close to 140,000 tons/year, which grew 5x since a decade ago.?

Thanks to urbanization, higher disposable incomes, social media and western influences, Malaysia’s coffee consumption has grown almost 2.5x from 2020-22. However, at roughly 2kg/capita/year of consumption, we are not even close to the top consumers, mainly the Scandinavian countries, who consume around 10kg/capita/year. Singapore also consumes around 50% more per capita. Hybrid work arrangements, trendy instagrammable cafes and the availability of new funky blends (I’ve tried one that I swear tasted like nangka) would further drive cafe visits and coffee consumption.?

In summary:?

Malaysia's thriving coffee sector is a major market that reflects our nation's evolving tastes and increasing coffee culture, driving significant investments into players like Zus and Oriental. Both local and international brands are capitalizing on this demand through a multitude of strategies, ensuring that the one thing we won’t have to worry about is a lack of choice for coffee.